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A common question we get from our CFO services clients is, how are Cost of Goods Sold (“COGS”) different from Operating Expenses (“OPEX”)? They’re both about spending money to allow your business to function; are they just two terms for the same thing? Which is which, and why does it matter?
The short answer is that no, COGS and OPEX are not the same thing. While they both constitute money your business is spending, they include different kinds of costs, and give you different information about the health of your business. Let’s take a closer look.
COGS: Creating Your Product
Cost of Goods Sold (COGS), sometimes called Cost of Revenue (COR) or Cost of Sales (COS) in businesses that provide services rather than physical goods, covers the money your business spends creating and delivering its product or service. This includes everything that goes into actually making the product and delivering it to your customers. It doesn’t include indirect or overhead costs like marketing, or rent for your facilities.
If your business sells a physical product, your COGS are fairly straightforward to identify. They might include things like the cost of raw materials that go into the product, the cost of manufacturing labor to assemble the product, and the cost of shipping the product to your customer.
For service businesses, COGS (or more accurately COR/COS) is less obvious – after all, you don’t have raw materials or manufacturing costs. The principle remains the same, however: if the cost is incurred by rendering your service to customers, it’s included here. If your company offers in-person services like coaching, your COGS/COR/COS might include things like the cost of paying your employees during the time they perform the service. If you offer digital services like SaaS, your COGS might include things like web hosting.
Let’s look at a few examples.
Example: COGS for a Company That Sells Physical Products
Sample Bread is a bakery that sells daily selections of breads, pastries, cookies, and other baked goods. In addition to its retail location, Sample Bread also sells boxes of cookies online through its website, which it then ships to customers. Sample Bread’s COGS include:
- Flour, sugar, eggs, butter, and various other baking ingredients
- Wages for its bakers
- Packaging for its finished baked goods
- Shipping costs for fulfilling its online orders
Example: COGS for a Company That Sells Services
Sample Learning is an education-tech company that offers online learning tools. For a monthly subscription fee, customers can access pre-recorded lessons from certified teachers on a variety of subjects through the Sample Learning app. Premium subscribers also receive a number of hours with an on-demand video tutor to give one-on-one guidance. Sample Learning’s COGS include:
- Hourly rates paid to the on-demand tutors
- Consulting fees paid to the teachers who participated in the pre-recorded lessons
- Rates paid to video production agency that filmed and edited the pre-recorded lesson videos
- AWS hosting costs for app and service content
Operating Expenses: Running Your Business
COGS reflects the direct costs of creating and delivering your product – which is the reason you have a business in the first place. But as you know, a lot more goes into running a business than just creating a thing and selling it. The workers creating your product or service need somewhere to work. The product needs to be marketed so that people want to buy it, and prospective buyers need their questions answered and their options explained. On top of that, the books need to be kept, the phones need to be answered, the taxes need to be paid.
Your operating expenses (OPEX) reflect these indirect, overhead costs of doing business. Categories included in OPEX include facilities costs (rent, utilities, any on-site perks), marketing and sales costs, business insurance, administrative costs (legal fees, finance help), and headcount costs (salary, benefits, etc) for those employees who are not associated with goods/services creation and delivery.
Your operating expenses do not include the costs of acquiring or investing in assets. Whether it’s purchasing a building to use as an office or upgrading your equipment, these kinds of costs are considered capital expenditures (CAPEX). While OPEX costs are related to your regular business operations or dispensable goods (e.g. office supplies), CAPEX costs are related to investments you make in assets that will add value to your business (e.g. building or non-leased vehicles) or have useful life (e.g. furniture). CAPEX is listed separately on your financial statements (statement of cash flows).
Example: OPEX for a Company That Sells Physical Products
Sample Bread’s operating expenses reflect the everyday costs of running a bakery:
- Rent for the bakery retail location
- Utilities for the retail location
- Cleaning supplies for keeping baking areas sanitary
- Maintenance fees for the ovens and other baking equipment
- Wages for the retail clerks, who also package and ship online orders
- Salary for the general manager
- Business insurance, fire insurance, worker’s comp insurance
- Recipe and equipment training for new employees
- Fees for contract bookkeeping, tax, and payroll professionals
- Ads on Instagram and Yelp, promoting popular or seasonal baked goods
Example: OPEX for a Company That Sells Services
Sample Learning’s operating expenses reflect the costs of running the startup:
- Rent for the HQ office
- Salaries for all employees not directly involved in product creation, including marketing, sales, HR, finance, management, facilities, and legal departments
- Business and rental insurance
- Utilities for the office
- Coffee and snacks offered to employees in the office
- Cost of PPC and offline advertising
- Administrative software licenses (HR platforms, expense management, etc)
- Software tools for marketing and sales management (marketing automation, CRM, etc)
- Fees for contract bookkeeping, tax, and payroll professionals
COGS vs. OPEX: Why It Matters
It’s important to understand the difference between COGS and OPEX, because each tells you something different about the state of your business. If your company is burning through too much cash, COGS and OPEX can help you zero in on what needs to change.
COGS tells you how efficient you are at creating your product, and factors significantly into how profitable you are. Your business might bring in a lot of revenue, but if creating your product is very expensive, you might still have low gross profits – which in turn will make it hard to cover your operating expenses.
If you find that your COGS is taking up a high proportion of your revenue, you know that there’s an opportunity to increase your profits by reducing your production costs. One option might be to lower your supplier costs – can you renegotiate your contracts, or find less costly suppliers through a procurement exercise? Another option might be to explore tools or training that might help your team work more efficiently, and produce more without raising costs.
OPEX, on the other hand, tells you how efficient you are at running your business overall. If you find that your OPEX is eating through your funds, then you can look at ways to tighten up your day-to-day spending. For example, you might look at how much you’re spending on marketing, and whether you’re getting an appropriate return on your investment. Other common ways that companies reduce their operating expenses are cutting back on facilities spending, or pausing hiring plans.
At first glance, COGS and operating expenses may seem similar, but both provide distinct and crucial insights into the state of your business. Use them both to get a fuller idea of what you’re spending and why – and if you’re getting the right value for your money.
Need some guidance? Pilot’s CFO services team is here to help.